The Morning Commentary: All for One and One for All

Foreign Exchange - Morning Commentary
All for One and One for All
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Overnight, it was reported that France and Germany have proposed a EU500 billion recovery program.  This proposal would be funded by additional borrowings to be repaid by the EU budget, much of which is covered by Germany.  Funds from this program will be used for grants to the EU members hardest hit by COVID-19.  If realized, this program represents a major step forward for the euro.   

The COVID-19 crisis has driven an increase in public sector debt and a decline in potential growth, two factors that should continue for the foreseeable future.  Granted, the Eurozone isn’t unique in having a deteriorating public finance picture due to COVID-19.  However, the euro is uniquely vulnerable due to the uneven debt burden within the region and the absence of mechanism, or political will, to put the sustainability of high debt, low growth countries beyond question.  The lack of a fiscal union has always been a design flaw in the European experiment and COVID-19 risks have only served to underscore this.     

Recently, the German Constitutional Court asked for clarification around the proportionality of the ECB’s QE program.  On a broad level, the German court’s ruling raises questions around the ECB’s ability to take on the same balance sheet measures that other central banks are doing.  This matters because without a deal to mutualize the debt of peripheral countries, the ECB serves as the ultimate debt guarantor insuring debt stability and euro stability.  The German court’s ruling potentially weakens this ECB backstop and adds another risk to the euro. 

That is why news reports that France and Germany have, for the first time, proposed to raise debt jointly is potentially a game changer.  Clearly it remains to be seen whether this gets realized as all 27 EU members have to unanimously approve it.  But if it does pass, it will be a major development and euro positive as it not only opens up the possibility for a more forceful fiscal response but also adds to euro stability. 
  • As mentioned above, the recovery plan suggested by France and Germany requires unanimous approval with Austria already expressing opposition to direct handouts.  German Chancellor Merkel also faces opposition at home, raising risks around final German support.  Notably, the EU500 billion proposed is much greater than the EU’s existing debt issuance.  Needless to say, Italy would be the clear winner if this comes to fruition.
  • Fed Chair Powell and Treasury Secretary Mnuchin will testify before Congress today.  Powell’s remarks were released yesterday and mirrors his 60 Minutes interview where he stated the Fed was prepared to use its “full range of tools.”  The Fed currently has 9 lending facilities.
  • The UK jobs report came in better than expected with the unemployment rate printing 3.9% against expectations for a 4.3% print.  Additionally, the economy added 210K jobs against expectations for 30K additional jobs.  Of course this data is backwards looking as it is for the month of March.  April jobs data will reflect the impact of COVID-19.
  • RBA minutes were released overnight and showed that the bank thinks its policies are working.  However, news reports suggest China could target more Australian exports as tensions rise.  Australia has called for an investigation into the origins of the pandemic. 
  • The BoJ will hold an unscheduled meeting this Friday to discuss new policy measures. 
  • Oil markets appear to be returning to historical norms.  The June WTI contract, that expires today, is at a premium to the July WTI contract, suggesting that storage concerns are easing.
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